What is NPV?
NPV (Net Present Value) is an important tool in assessing investments and takes into account the time value of money. If you could have £100 today or £100 in 5 year’s time – what would you go for? If you have £100 today you could invest it and potentially make more money.
To take this into account, we discount the value of future cash flows and the further out we look the more we discount to bring the values in line with what they are worth today.
What discount rate should you use?
There are two ways to look at this – you could look at using the interest rate or return that you could achieve by investing the money elsewhere or generally we use the required rate of return of the investor or the hurdle rate.
What does NPV tell me?
NPV looks at the total cash flows of the project. A positive NPV for a project suggests that the investment project should go ahead while if negative, it would suggest that a project should be rejected.